Accounts receivable is an accounting term that refers to sales for which payment has not yet been received. The customer has not paid for the good or service received at the time of the transaction. Instead, the business has extended credit to the customer and expects to receive payment for the transaction at some point in the future.
In contrast, for the customer who owes the payment, the transaction will be recorded as an account payable. The two are opposite representations of the same transaction. While the two parties to the transaction do not share accounting books, their entries should cancel each other out.
For example: an account receivable for business A (money to be paid) for a $100 product sold will equal an account payable (money owed) by business B for the same amount. When the payment has been made, the transaction will have zeroed out for both entities. Business A will have received its $100, and business B will no longer owe a $100 payment for the product it received.
Accounts receivable are an important accounting metric. They represent convertible assets owed to the company. That is, they describe a financial resource that can be converted to cash in the near future, once the customer has paid. Similarly, they are the basis for measuring the business’s ability to convert sales into cash. When payments are not collected for accounts receivable, this is an indicator that the business is not performing.
Accounts receivable are typically collected in two months or less. For this reason, they are considered a “short-term asset” which refers to any financial resource that can be converted to cash in one year or less.
A business that extends credit to customers is demonstrating trust and extending goodwill. This can help the business expand its customer base, which will generate more revenue. On the other hand, some customers may not pay. This creates bad debt for the business. In this way, accounts receivable are like investments. They come with rewards as well as risks.
